City Comment: Libor crisis will change face of banking

Clearer skies? but interbank rate is still far above the Bank of England base figure

The move towards a world where people have to use their own money for buying, rather than borrowing that of others, has taken another lurch forward.

The reason? The Libor debacle. It is very difficult at this early stage to put hard numbers on the costs to the banks that will result from fines, still less from the legal actions likely to be taken against them. But it is already clear that it will hasten a change in the culture of the whole industry and also the speed at which it will inevitably shrink.

In the coming weeks, we will have a string of news stories about the fines being levied on the other big banks involved in setting Libor. Presumably these will be larger than that imposed on Barclays, which hoped that, by doing a deal swiftly, it would gain more lenient treatment. So we are talking in billions. You could say that in relation to the size of the industry this will be bearable. Put it this way: the fines will be small when compared with the losses the banks have had to take from dodgy property lending. However, the private legal actions may be another matter. We will have to wait and see.

But this story is not just about damage to the banks. It is about damage to the banking system. Libor is the most important single measure of the price of money, which in turn affects the price of loans. Thus the entire international syndicated loan market is undermined. It is quite hard for us now to remember a world before the money markets existed — before Libor was coined to describe the rates at which banks lent to each other on them.

Libor dates back to the 1960s, to the early days of the Eurocurrency markets, when London-based banks suddenly hit on the idea that they might trade deposits in dollars and other currencies with each other over the phone. Syndicated lending, splitting up loans between a group of banks, took off on an international scale when banks could be confident that they could go into the market and buy the deposits they needed to fund their bit of the loan.

The London-based deposit markets have financed much of the great expansion of the world economy since then. Of course, the growth could have been financed by securities-markets instruments rather than bank loans, and that is now happening. Large companies can raise money by issuing bonds, at the moment at stunningly low costs. Last week, Nestlé raised money at a cheaper rate than France, which tells us something about investors’ perception of relative risk.

That is great if you are a huge and famous company. It is not so great if you are smaller and less well-known. So while there are other ways of raising money, and those ways will develop further, the international banking system built round Libor is — or at least was — swift and efficient. It became corrupted, and no one disputes

that. But when the system was working reasonably well, as it did for most of the period between the 1960s and the early 2000s, it was a great driver of global growth.

The net effect of a loss of trust in Libor is a loss of trust in banking as an industry. Pull all this together and it seems to me that there are at least four ways in which the Libor disaster will undermine banking globally.

First, bankers will be more cautious about everything. They will see their duty much more in fiduciary terms. They will be custodians of other people’s money, rather than go-getters taking risks, because they will punished if the risks they take go wrong and they will not be rewarded if they go right.

Second, the cost of fines and other legal actions will directly reduce their profits. That will make it harder to raise the funds they need to meet the increased capital requirements being imposed on them. If they cannot raise capital, the only way of meeting the new requirements will be to shrink their loan book.

Third, quite aside from the direct impact on their capital-raising ability, there is an indirect impact on this from the reputational damage associated with the disaster. Who wants to invest in an industry you don’t trust?

Finally, the core commercial business of making loans tied to Libor has been undermined and will inevitably shrink further, because

the damage to Libor will reduce the willingness of companies to borrow as well as the ability of banks to lend. It affects the demand side as well as the supply side.

So: banking becomes smaller. We will all borrow less and we will pay back debt faster. Companies will rely on retained profits to fund expansion, as they used to. New ventures will have to attract real risk capital, not rely on bank loans. It will, in short, be a world where banks have to say “no” rather than like to say “yes”.